Understanding liquidity & what it means for you.
As someone who has spent their working life creating and building a successful company, you have probably accumulated significant assets. Your portfolio could include any combination of cash, real estate, stocks, bonds, annuities, insurance policies and precious metals. Some investors trade more complicated instruments like commodity futures or options. Each of these investments are a separate asset class. To fully understand your portfolio, you must have a solid grasp of the concepts of liquidity, volatility, and diversity.
A wise investor usually seeks diversity in his portfolio, spreading out his wealth over several asset classes. Sometimes one class is an excellent hedge against another. For example, when cash loses its value gold usually gains. Most well managed portfolios are usually further diversified over industry sectors. And as always, a prudent investor balances his risk with the potential reward. Most business owners are too busy trying to run their businesses to trade securities and usually leave that to investment advisers.
Recently we asked a client to identify his personal assets and assign a value to them. He gave us this list:
What did this tell us? He had ignored his biggest asset, his business! The business was worth $6,000,000. About two thirds of his net wealth. We reminded him of that and he said “Oh, yes! That too!” When you are a successful business owner, your business is probably your biggest asset. Which means, by definition, you do not have a lot of diversity.
The reason he didn’t immediately think of his business as an asset is because it was more like a family member to him. He had nurtured the company from its infancy, just like he and wife had raised their kids. He had other people managing his cash and properties, so there was little emotion involved there other than some concern when the stock market got a little volatile from time to time. He had lived very well and made good investments with the income from the business. In fact, he had been in an extremely competitive business and had put several once formidable competitors on the ropes. When we asked him about his future plans, he told us that he and his wife had always planned to liquidate everything when he turned 65 and move to their condo in Florida.
Our client was in the printing business. With the tech boom of the nineties the demand for printed material plummeted. With the advent of personal computers, desktop publishing and laser printers, anyone could be in the printing business. Other traditional printing business disappeared thanks to the Internet. Online coupons and newsletters appeared almost overnight further reducing demand. Suddenly the printing business was a shark tank of epic magnitude. There was still demand for printed material of course, but very quickly the successful printers were those that could offer wide format and other options that could only be produced by the most modern equipment. The neighborhood printing shop went the way of the telephone booth.
Fortunately for our client, he had always modernized his operation regularly. He was one of the survivors. Many of his competitors watched their sizable operations quickly dwindle to a fraction of their former volume. We know this because we helped him buy several of his former rivals at bargain basement prices. To further compound the problems of the vanquished, their equipment had very little value due to its outmoded capabilities. There are thousands of old Heidelburg printing machines sitting around in warehouses waiting for a call that will never come.
The managers you hire to look after your securities and real estate portfolios examine the risks of holding them on a very regular basis. And when that manager gets a tiny whiff of trouble on the horizon for your a stock you own, he can liquidate it in less than a minute. A stock has immediate liquidity. And in a volatile market, liquidity is crucial. If you owned Enron stock in 2001 and suspected that it was in trouble, you needed only call your stockbroker and tell him to dump it. Two minutes later, you’re out. No need to ride it from $100 down to five cents.
Enron’s stock tanked for one reason and one reason only. Nobody wanted to buy it. Supply outstripped demand gradually at first, but as suspicion of their accounting irregularities mounted, the stock gradually dropped to less than a tenth of its all-time high. When a last minute suitor backed out, the price went from five dollars to five cents in five minutes. And some people who had worked their whole lives at Enron saw their entire pension holdings disappear because they were locked into a managed fund that required them to maintain their investment in Enron. This is the worst possible situation for an investor to be in. The volatility of the stock market made it easy for their holdings to be decimated quickly, but lack of liquidity due to the restrictions of their own fund made it impossible for them to do anything but stand by and watch their portfolios disappear along with their retirement plans.
What could affect the volatility of the market for your business? Not the markets you serve, but the acquisitions climate for your the business you own? New technology that supplants yours? New public policy like Obamacare? Or just a new competitor on the block that is well capitalized, well organized, and wants to pick a fight with you. When you sense volatility that is going against you, and the asset in question is a stock, you liquidate quickly. But if the asset in question is your business, are you prepared to sell? Most are not.
If your biggest asset is your business, and you are not prepared to sell it if necessary, you are just like those Enron investors. No liquidity in volatile market. You will never sell your businesst as dispassionately as you would a stock or an apartment building, but you need to understand that for there to be any demand for it you must be able to prove what you have. It can take weeks or months to sell a business at fair market value, and much longer if you are not prepared.
At any given time, you must balance the answers to these questions:
“If I sold now and locked in what I’ve built, what would the rest of my life be like?”
“If the value of my business plummeted, what would the rest of my life be like?”
As long as you are experiencing growth and profitability, you should probably keep at it. Why not? The major determinants of your company’s value are profitability and growth trend. When you sell your business, you are selling a future income stream. Nothing will detract from your company’s value more than declining profitability.
There are no hard and fast rules that tell you when your business is worth as much as it ever will be. And But there are things that you can do to be prepared when you think the time has come that will give you a degree of liquidity that those Enron employees did not have. We can help you prepare now to be ready to put your business on the market when you want to, but even more importantly, we can help you be ready to sell quickly if you need to.
© Players Capital Group 2016
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